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entitled 'Auto Industry: A Framework for Considering Federal Financial
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Testimony:
Before the Committee on Financial Services, House of Representatives:
United States Government Accountability Office:
GAO:
For Release on Delivery:
Expected at 9:30 a.m. EST:
Friday, December 5, 2008:
Auto Industry:
A Framework for Considering Federal Financial Assistance:
Statement of Gene L. Dodaro:
Acting Comptroller General of the United States:
GAO-09-247T:
GAO Highlights:
Highlights of GAO-09-247T, a testimony before the Committee on
Financial Services, House of Representatives.
Why GAO Prepared This Statement:
The current economic downturn has brought significant financial stress
to the auto manufacturing industry. Recent deteriorating financial,
real estate, and labor markets have reduced consumer confidence and
available credit, and automobile purchases have declined. While auto
manufacturers broadly have experienced declining sales in 2008 as the
economy has worsened, sales of the “Big 3” (General Motors, Chrysler,
and Ford) have also declined relative to those of some other auto
manufacturers in recent years because higher gasoline prices have
particularly hurt sales of sport utility vehicles.
In addition to causing potential job losses at auto manufacturers,
failure of the domestic auto industry would likely adversely affect
other sectors. Officials from the Big 3 have requested, and Congress is
considering, immediate federal financial assistance.
This testimony discusses principles that can serve as a framework for
considering the desirability, nature, scope, and conditions of federal
financial assistance. Should Congress decide to provide financial
assistance, we also discuss how these principles could be applied in
these circumstances. The testimony is based on GAO’s extensive body of
work on previous federal rescue efforts that dates back to the 1970s.
What GAO Found:
From our previous work on federal financial assistance to large firms
and municipalities, we have identified three fundamental principles
that can serve as a framework for considering future assistance. These
principles are (1) identifying and defining the problem, (2)
determining the national interests and setting clear goals and
objectives that address the problem, and (3) protecting the
government’s interests. First, problems confronting the industry must
be clearly defined—separating out those that require an immediate
response from those structural challenges that will take more time to
resolve. Second, Congress should determine whether the national
interest will be best served through a legislative solution, or whether
market forces and established legal procedures, such as bankruptcy,
should be allowed to take their course. Should Congress decide that
federal financial assistance is warranted, it is important that
Congress establish clear objectives and goals for this assistance.
Third, given the significant financial risk the federal government may
assume, the structure Congress sets up to administer any assistance
should provide for appropriate mechanisms, such as concessions by all
parties, controls over management, compensation for risk, and a strong
independent board, to protect taxpayers from excessive or unnecessary
risks.
These principles could help the Congress in deciding whether to offer
financial assistance to the domestic auto manufacturers. If Congress
determines that a legislative solution is in the national interest, a
two-pronged approach could be appropriate in these circumstances.
Specifically, Congress could 1) authorize immediate, but temporary,
financial assistance to the auto manufacturing industry and 2)
concurrently establish a board to approve, disburse, and oversee the
use of these initial funds and provide any additional federal funds and
continued oversight. This board could also oversee any structural
reforms of the companies. Among other responsibilities, Congress could
give the board authority to establish and implement eligibility
criteria for potential borrowers and to implement procedures and
controls in order to protect the government’s interests.
Figure: Number of Vehicles Sold By the Big 3, 2004 to 2008:
[Refer to PDF for image]
This figure is a line graph depicting the number of vehicles sold by
the Big 3, 2004 to 2008. The vertical axis of the graph represents
vehicles sold, in hundreds of thousands. The horizontal axis of the
graph represents months from 2004 through 2008. The following data is depicted:
Date: January, 2004;
Vehicles sold: 663,791.
Date: July, 2004:
Vehicles sold: 919,910.
Date: January 2005;
Vehicles sold: 618,520.
Date: July, 2005;
Vehicles sold: 1,119,540.
Date: January 2006;
Vehicles sold: 647,902.
Date: July, 2006;
Vehicles sold: 790,971.
Date: January, 2007;
Vehicles sold: 561,714.
Date: July, 2007;
Vehicles sold: 642,365.
Date: January, 2008;
Vehicles sold: 543,964.
Date: July, 2008;
Vehicles sold: 492,434.
Date: October, 2008;
Vehicles sold: 395,497.
Source: IHS Global Insight.
[End of figure]
To view the full product, including the scope and methodology, click on
[hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-09-247T]. For more
information, contact Katherine Siggerud at (202) 512-2834, J.
Christopher Mihm at (202) 512-3236, or Gary L. Kepplinger at (202)-512-
5400.
[End of section]
Chairman Frank, Ranking Member Bachus, and Members of the Committee:
We appreciate the opportunity to testify on possible federal assistance
to the domestic auto industry. The current economic downturn has added
to the significant financial stress facing that industry. Deteriorating
financial, real estate, and labor markets have reduced consumer
confidence and available credit, and automobile purchases have
declined. After reaching a recent high of about 1.8 million in July
2005, the number of vehicles sold in the United States dropped to about
800,000 in October 2008, approximately a 54 percent decline. While most
auto manufacturers have experienced declining sales in 2008, recent
economic conditions have particularly hurt sales of the "Big 3"
domestic auto manufacturers (General Motors, Ford, and Chrysler), in
part because these companies have historically derived most of their
sales from vehicles such as sport utility vehicles, which are less fuel
efficient, but more profitable than small cars. Higher gasoline prices
over the past several years, which rose to over $4 per gallon in the
summer of 2008 before falling steeply this fall, have contributed to a
sharp decline in consumer demand for these vehicles. The tightening of
the credit markets has also affected the Big 3 and their suppliers,
which together employ about 730,000 people. In addition to potential
job losses at auto manufacturers, the collapse or partial collapse of
the domestic auto industry would adversely affect auto dealers,
suppliers, and other sectors.
Officials from the Big 3 have requested immediate federal financial
assistance, reporting that their companies are experiencing significant
financial stress.[Footnote 1] Less than three days ago, the Big 3
submitted business plans to Congress that describe their requests for
federal assistance and restructuring plans. Congress has asked us to
review these plans. In deciding whether to provide financial
assistance, Congress must consider and balance the perceived need for
expedience with the need to put a structure in place to ensure that the
interests of taxpayers are safeguarded and the specific problems that
have put the industry in its current financial crisis are addressed.
In my statement today, I will discuss principles that could serve as a
framework for considering the desirability, nature, scope, and
conditions of possible federal financial assistance and, should
Congress decide to provide financial assistance, how these principles
could be applied in these circumstances. My remarks are based on our
extensive body of work on previous federal financial assistance efforts
that dates back to the 1970s, including those efforts directed to
individual large corporations, such as the Chrysler Corporation and
Lockheed Aircraft Corporation, as well as municipalities and commercial
aviation.[Footnote 2]
Summary:
From our previous work on federal financial assistance to large firms
and municipalities, we have identified three fundamental principles
that can serve as a framework for considering future assistance. First,
the problems confronting the industry need to be clearly defined--
distinguishing between those that require an immediate financial
response from those that are likely to require more time to resolve.
Second, Congress must determine whether the national interest will be
served best through a legislative solution, or whether market forces
and established legal procedures, such as bankruptcy reorganization,
should be allowed to take their course. Should Congress decide that
federal financial assistance is warranted, it is important that
Congress establish clear objectives and goals for this assistance.
Third, given the significant financial risk the federal government may
assume on behalf of taxpayers, the structure Congress sets up to
administer any assistance should provide for appropriate mechanisms,
such as concessions by all parties, controls over management,
compensation for risk, and a strong independent board, to protect
taxpayers from excessive or unnecessary risks.
Congress could apply these principles when deciding whether to offer
any financial assistance to the domestic auto manufacturers. If
Congress determines that a legislative solution is in the national
interest, a two-pronged approach in applying the principles could be
appropriate in these circumstances. Specifically, Congress could 1)
authorize immediate, but temporary, financial assistance to the auto
manufacturing industry and 2) concurrently establish a board to
approve, disburse, and oversee the use of these initial funds and
provide any additional federal funds and continued oversight. This
board could also oversee any structural reforms of the companies. Among
other responsibilities, Congress could give the board authority to
establish and implement eligibility criteria for potential borrowers
and to implement procedures and controls in order to protect the
government's interests.
Principles for Large-Scale Federal Financial Assistance Efforts Could
Guide Congressional Consideration of Auto Manufacturers' Requests:
We have identified three fundamental principles that can serve as a
framework for considering large-scale federal assistance efforts. These
principles are (1) identifying and defining the problem, (2)
determining the national interests and setting clear goals and
objectives that address the problem, and (3) protecting the
government's interests.
* Identify and define the problem: The government should clearly
identify and define the specific problems confronting the industry--
separating out those that require an immediate response from those
structural challenges that will take more time to resolve. According to
the auto manufacturers, the most immediate threat to the industry comes
from inadequate cash reserves and negative projected cash flows
combined with a tightening or denial of credit by commercial lending
institutions. General Motors and Ford have not been profitable since at
least 2006, and sales have decreased substantially for the Big 3 in
2008.[Footnote 3] In this regard, deteriorating financial and real
estate markets, weakening labor markets, and high fuel prices have
contributed to reductions in consumers' demand for new vehicles,
particularly less fuel-efficient vehicles. In addition, tightening
consumer credit has made it difficult for some consumers to obtain auto
loans. The industry, however, also faces structural challenges that
will need to be dealt with, including higher labor and pension costs
than competitors, dealership relationships and structure, and fleet
characteristics--especially in the area of fuel efficiency.
* Determine national interests and set clear goals and objectives that
address the problem: After defining the problem, Congress must
determine whether a legislative solution best serves the national
interest. If Congress determines that the benefits of federal
intervention exceed those of bankruptcy reorganization for one or more
of the domestic manufacturers, Congress could draft legislation to
guide the availability and use of federal assistance. It is important
that the legislation include a clear and concise statement of the
objectives and goals of the assistance program. A statement of the
objectives and goals of the program would help Congress and program
administrators determine which financial tools are needed and most
appropriate for the industry and for company-specific circumstances;
provide criteria for program decisions; and serve as a basis for
monitoring progress. Finally, although Congress may decide that there
is a compelling national interest in providing financial assistance to
help ensure the long-term viability of the Big 3, companies receiving
assistance should not remain under federal protection indefinitely.
Identifying the conditions that will signal an end to that protection
would serve as congressional guidance on when the industry should
emerge from the assistance program.
* Protecting the government's interest: Because these assistance
programs pose significant financial risk to the federal government,
appropriate mechanisms should be included to protect taxpayers from
excessive or unnecessary risks. Mechanisms, structures, and protections
should be implemented to ensure prudent use of taxpayer resources and
manage the government's risk consistent with a good faith attempt to
achieve the congressional goals and objectives of any federal financial
assistance program.[Footnote 4] This can be achieved through the
following four actions--all of which have been used in the past.
[Footnote 5]
1. Concessions from others: Congress should require concessions from
others with a stake in the outcome--including management, labor,
suppliers, dealers, and creditors. The concessions are not meant to
extract penalties for past actions, but to ensure cooperation and
flexibility in securing a successful future outcome.
2. Controls over management: The government must have the authority to
approve an aid recipient's financial and operating plans and new major
contracts. The authority is meant to ensure a restructuring plan with
realistic objectives and to hold management accountable for achieving
results.
3. Collateral: To the extent feasible, the government should require
that the recipient provide adequate collateral, and that the government
be in a first lien position.
4. Compensation for risk: The government should receive compensation
through fees and/or equity participation in return for providing
federal aid. The government's participation in any upside gains is
particularly important if the program succeeds in restoring the
recipient's financial operational health.[Footnote 6]
Using the Principles As A Framework for Considering Financial
Assistance for the Auto Manufacturing Industry:
Congress could apply these principles if it decides to offer financial
assistance to the domestic auto manufacturers. If Congress determines
that the systemic, economic consequences of risking the immediate
failure of any or all of these companies are too great, a two-pronged
approach in applying the principles could be appropriate. Specifically,
Congress could 1) authorize immediate, but temporary, financial
assistance to the auto manufacturing industry and 2) concurrently
establish a board to approve, disburse, and oversee the use of these
initial funds and provide any additional federal funds and continued
oversight. This board could also oversee any structural reforms of the
companies. Among other responsibilities, Congress could give the board
authority to establish and implement eligibility criteria for potential
borrowers and to implement procedures and controls in order to protect
the government's interests.
The federal government has a range of tools it could use to provide
such bridge assistance, including loans and loan guarantees.[Footnote
7] Historically, the federal government has used loans and loan
guarantees in its financial assistance to specific companies. In
providing such credit assistance, the government has assumed that the
federal role is to help the industry overcome a cyclical or event-
specific crisis by gaining access to cash in the short term that it
otherwise cannot obtain through the markets. Credit assistance assumes
that the aided companies will eventually return to financial health and
have the capacity to pay back the loans. The government has offered
such assistance in return for companies providing various forms of
collateral and/or equity to protect taxpayer interests, as well as for
various concessions by interested parties to share the risk and promote
shared responsibility. For example, any federal assistance to an auto
manufacturer might seek to ensure that all parties, including labor and
management, share responsibility for bringing the company back to
profitability, and that no party makes excessive concessions relative
to the other parties. Finally, accountability should be built in so
that Congress and the public can have confidence that the assistance
was prudent and consistent with the identified objectives. For example,
as a condition for receiving federal assistance, the auto manufacturers
should be required to provide program administrators and appropriate
oversight bodies with access to their financial records and submit
detailed operating and financial plans indicating how the funds and
other sources of financing will be used to successfully return the
companies to profitability. Such information would allow program
administrators to oversee the use of funds and to hold the companies
accountable for results.
Congress should concurrently establish a board to approve, disburse,
and oversee the use of these initial funds and provide any additional
federal funds and continued oversight. This board could also oversee
any structural reforms of the companies. The federal government has
established boards to implement past financial assistance efforts,
including when providing assistance to Lockheed in 1971 and Chrysler in
1980. More recently, in the aftermath of the 2001 terrorist attacks on
the United States, Congress created the Air Transportation
Stabilization Board (ATSB) to provide loan guarantees to the airline
industry. The voting members of ATSB included a member of the Board of
Governors of the Federal Reserve System and representatives from the
Departments of the Treasury and Transportation. While the exact
membership of a board to provide financial assistance to the Big 3 auto
manufacturers could differ, past federal financial assistance efforts
suggest that it would be prudent to include representatives from
agencies knowledgeable about the auto manufacturing industry as well as
from those agencies skilled in financial and economic analysis and
assistance. In creating such a board, it will be crucial for Congress
to ensure that the board, similar to boards created to implement past
federal financial assistance efforts, has access to all financial or
operational records for any recipients of federal assistance so that
informed judgments and reviews can occur.[Footnote 8] It would also be
important to ensure that the board has the authority and resources to
hire or contract for necessary legal, financial, and other expertise.
[Footnote 9] For example, ATSB hired an executive director, financial
analyst, and legal counsel to help the board carry out its duties.
Beyond access to records and expertise, however, to succeed in
achieving the goal of a restructured industry, the board is likely to
need the authority to implement procedures and controls to protect the
government's interests. This would include bringing the parties with a
stake in a successful outcome to the table. Our review of past large-
scale financial assistance efforts leads us to conclude that all of
these parties must make concessions--not as penalties for past actions
but rather to ensure cooperation in securing a successful future. The
board would also need authority to approve the borrower's operating and
financial plans and major new contracts to ensure the plans are
realistic and to assess management's efforts in achieving results. In
addition, the federal government should be the first creditor to be
repaid in the event of a bankruptcy or when the company returns to
profitability. In 1980, when providing assistance to Chrysler, Congress
mandated that Chrysler meet additional policy-oriented requirements
such as achieving certain energy efficiency goals and placed limits on
executive compensation. More recently, as a condition of receiving
federal assistance in the wake of the September 11 terrorist attacks,
the Air Transportation Safety and System Stabilization Act required
that airlines limit executive compensation.[Footnote 10]
In addition, the board, consistent with congressional direction, could
require that manufacturers, with the cooperation of labor unions, take
steps to help control costs. Such steps could include reducing excess
capacity by closing or downsizing manufacturing facilities, reducing
work-rule restrictions that limit flexibility in terms of which workers
can do what types of jobs, and ending contracts with dealerships that
require the manufacturer to pay a large buyout to a dealer if a product
line is eliminated. Some of these steps should be specifically
addressed in the legislation. It will be important to keep in mind,
however, that the affected parties will cooperate only if the
assistance program offers a better alternative than bankruptcy. The
government should not expect creditors, for example, to make
concessions that will cost them more than they would expect to lose in
a bankruptcy proceeding.[Footnote 11] Finally, Congress should provide
the board with enough flexibility to balance requirements in each
recipient's business plan to achieve and maintain profitability.
The board could be the logical entity to establish and implement
clearly defined eligibility criteria for potential borrowers,
consistent with statutory direction provided by Congress, and establish
other safeguards to help protect the government's interests and limit
the government's exposure to loss. The safeguards could vary, depending
on the nature of the financial assistance tools used. Examples of
safeguards over loans and loan guarantees that have been used in the
past include the following:
* Potential borrowers have been required to demonstrate that they meet
specific eligibility criteria, consistent with congressional direction
as to the problems to be addressed and the objectives and goals of the
assistance.
* Potential borrowers have been required to demonstrate that their
prospective earning power, together with the character and value of any
security pledged, provided reasonable assurance of repayment of the
loan in accordance with its terms.
* Potential borrowers have been required to clearly indicate the
planned use of the loans so that the board could make appropriate
decisions about the borrower's financial plan and terms and conditions,
as well as collateral.
* The government has charged fees to help offset the risks it assumed
in providing such assistance.
* For loan guarantees, the level of guarantee has been limited to a
given percentage of the total amount of the loan outstanding.
To further enhance accountability and promote transparency, the board
should monitor the status of federal assistance on a regular basis and
require regular reporting from companies receiving assistance. This
reporting should, at a minimum, include information on cash flow,
financial position, and results of independent audits. In addition, the
board should be required to provide periodic reports to Congress. This
reporting should include status reports on the amount and types of
assistance provided to the auto manufacturing industry, periodic
assessments of the effectiveness of the assistance, and status of any
repayments of loans that the federal government has provided to the
industry.
In addition to providing oversight and accountability of the federal
funds, the board could be charged with overseeing efforts of the
assisted companies to implement required changes and reform. The board
would likely need to consider industry-specific issues in implementing
financial assistance and industry reform. Employee compensation would
be one of those issues, and a very complex one. Benefits for auto
industry workers represent a significant long-term financial commitment
of the companies seeking assistance, much of it to retirees and their
families. Although success in a company's future will depend in part on
sacrifice from all stakeholders, most of the changes in this area will
necessarily take effect over the long term. The complexities of these
arrangements and their interface with active workers and with existing
government programs will make implementing federal assistance
particularly challenging. For example, the board would need to consider
the impact that a possible bankruptcy filing by an auto manufacturer
would have on the Pension Benefit Guaranty Corporation, the federal
agency that insures private employers' defined benefit pensions, and
whose cumulative balance is already negative.
Concluding Observations:
In conclusion, Congress is faced with a complex and consequential
decision regarding the auto manufacturers' request for financial
assistance. The collapse or partial collapse of the domestic auto
manufacturing industry would have a significant ripple effect
throughout other sectors of the economy and serve as a drag on an
already weakened economy. However, providing federal financial
assistance to the auto manufacturing industry raises concerns about
protecting the government's interests and the precedent such assistance
could set for other industries seeking relief from the current economic
downturn.
My remarks today have focused on principles Congress may wish to
consider as it contemplates possible financial assistance for the auto
manufacturing industry. These principles are drawn directly from GAO's
support of congressional efforts over several decades to assist
segments of industries, firms, the savings and loan industry, and
municipalities. Although the principles do not provide operational
rules outlining exactly what should be done, they do provide a
framework for considering federal financial assistance. By defining the
problem, determining whether a legislative solution to that problem
best serves the national interest, and--assuming that such a solution
is appropriate--establishing an appropriate governance structure,
Congress might better assure itself and the American people that the
federal assistance will achieve its intended purpose.
Thank you Mr. Chairman, Ranking Member Bachus, and members of the
committee for having me here today. We at GAO, of course, stand ready
to assist you and your colleagues as you tackle these important
challenges.
Contacts:
For further information on this testimony, please contact Katherine A.
Siggerud on (202) 512-2834 (auto industry issues), J. Christopher Mihm
on (202) 512-3236 (GAO's principles), and Gary L. Kepplinger on (202)
512-5400 (legal issues).
[End of section]
Footnotes:
[1] For example, as of September 30, 2008 General Motors reported total
liabilities of over $169.4 billion with total assets of about $110.4
billion, resulting in negative equity of nearly $59 billion. General
Motors has requested total financial assistance of $18 billion. As of
September 30, 2008 Ford reported total liabilities of debt of about
$242.6 billion with total assets of about $242.1 billion, resulting in
negative equity of approximately $0.5 billion. Officials from Ford have
requested a "stand-by" line of credit up to $9 billion, to be used if
conditions worsen. Because Chrysler is privately owned, data on its
financial condition is not currently available to the public.
Nevertheless, officials from Chrysler have stated that without
immediate assistance, its liquidity could fall below the level
necessary to sustain operations. Chrysler has requested $7 billion of
financial assistance.
[2] GAO, Troubled Financial Institutions: Solutions to the Thrift
Industry Problem [hyperlink,
http://www.gao.gov/products/GAO/GGD-89-47], Feb. 21, 1989, Resolving
the Savings and Loan Crisis [hyperlink,
http://www.gao.gov/products/GAO/T-GGD-89-3], Jan. 26, 1989, Guidelines
for Rescuing Large Failing Firms and Municipalities [hyperlink,
http://www.gao.gov/products/GAO/GGD-84-34], Mar. 29, 1984, and
Commercial Aviation: A Framework for Considering Federal Financial
Assistance [hyperlink, http://www.gao.gov/products/GAO-01-1163T], Sept.
20, 2001.
[3] Chrysler is a private company and does not report its profits or
losses publicly.
[4] [hyperlink, http://www.gao.gov/products/GAO-01-1163T].
[5] [hyperlink, http://www.gao.gov/products/GAO/GGD-84-34].
[6] In a previous financial assistance package for Chrysler, the
government obtained equity participation in the form of warrants that
allow the government to purchase shares of a recipient's stock at a
specified price. A decision on whether equity participation should be
included as well as its form and amount should be made on a case-by-
case basis.
[7] Loan guarantees help borrowers obtain access to credit with more
favorable terms than they may otherwise obtain in private lending
markets because the federal government guarantees to pay lenders if the
borrowers default, which makes extending credit more attractive to
lenders. Loan guarantees have the advantage of encouraging private-
sector participation and potential expertise, with higher levels of
federal guarantees likely generating the most participation. The Office
of Management and Budget's Circular A-129, Policies for Federal Credit
Programs and Non-Tax Receivables prescribes policies and procedures for
justifying, designing, and managing federal credit programs. This
guidance states that lenders should have a substantial stake in full
repayment, generally 20 percent. Limiting the federal guarantee to 80
percent ensures that lenders share in the risks associated with the
loan. However, given the current problems in the credit sector, lenders
may be unable to provide large loans and unwilling to accept such
risks.
[8] In addition, prior federal assistance programs for failing firms
and municipalities gave GAO the authority to audit the accounts of the
recipients and the right of access to the records needed to do so. This
authority enabled GAO to support congressional oversight of the
assistance program.
[9] Staff could also be detailed from federal agencies represented on
the board to support the board's review and oversight function.
[10] P.L. No. 107-42.
[11] [hyperlink, http://www.gao.gov/products/GAO/GGD-84-34].
[End of section]
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